Investing in Oil: 5 Junior Oil Stocks for 2012

If I had to pick 5 Canadian junior energy stocks for 2012 they would be: Arcan Resources, Hyperion Exploration, Spartan Oil, Pinecrest Energy and Wildstream Exploration. These 5 stocks that I will be discussing in this post share certain traits that are by no means exclusive to them (bias warning). There are countless others out there that could fit the description but I will only be discussing these 5 because I am or I’ve been an investor in one of these companies. No one knows what’s in store for 2012 when it comes to the economy; the markets might implode on the back of a black swan event or simply remain range bound for the whole year reflecting a tepid recovery. In hindsight, current price levels might turn out to be excellent entry points as those who are capable of execution will be rewarded. So if I had to pick 5 Canadian junior energy stocks for 2012, why would I choose these ones?

Liquids Focus

How about we start with the production weighting, it would have to be weighted to lightoil and that is simply because natural gas prices will remain under pressure mainly as long as export facilities are not operational. Assuming oil prices settle in a comfortable range (WTI around $80 US) for both the economy and the producers, I believe these companies will be more than fine because at these price levels the profit per barrel is very attractive.

Company

Production on January 1, 2012

Oil & NGL Weighting

Arcan Resources

>6,000 boe/d

>94%

Hyperion Exploration

>1,500 boe/d

>67%

Spartan Oil

>1,000 boe/d

75%

Pinecrest Energy

>3,000 boe/d

100%

Wildstream Exploration

>6,800 boe/d

93%

Please take note that I believe all of these companies will exceed their exit guidance for 2011 mostly because of new completion techniques being implemented and superior execution. It’s true that there are other producers with a higher weighting to light oil than our Cardium juniors but there are more variables that come into play.

Asset Quality: Exploitation NOT Exploration

If I want to reduce my risk, I would go with a company in an exploitation phase not an exploration phase. I prefer not to invest in a company exploring its land base or trying to figure out the best method to extract hydrocarbons with my money. It costs a lot of money to do that as you could run through a lot of disappointments before you get the results you’re hoping for. I believe it’s better to focus on land where oil is KNOWN to be there and where the extraction method is proven and repeatable. We’re looking for companies with a low risk development profile with a predictable, scalable and repeatable light oil resource play.

Company

Resource Play

Land

Arcan Resources

Beaver Hill Lake Group

171 net sections

Hyperion Exploration

Cardium

33 net sections

Spartan Oil

Cardium

43 net sections

Pinecrest Energy

Slave Point

97 net sections

Wildstream Exploration

Upper/Lower Shaunavon

230 net sections

These resource plays have been derisked by ever improving completion methods; they are considered geologically speaking “low risk”. We know the oil is there and by holding a significant land position these companies assembled an inventory of wells they can drill, complete, tie-in, rinse and repeat. Spartan Oil’s Saskatchewan land base adds exploration upside and the same can be said for Wildstream’s 15 net sections at Swan Hills without forgetting its 110 net sections of Viking land in Dodsland, Saskatchewan. The economics for these plays will vary so it is up to you to pick a favorite.

Management Track Record

I want to invest with a management team that has a history of success. Pinecrest CEO Wade Becker is a cofounder of Crescent Point Energy, enough said. Trevor Spagrud founded and sold Titan Exploration and Spartan Oil’s Rick McHardy built and sold Spartan Exploration not long ago. Both management teams from ARN and WSX are strong and experienced as well. These men have proven their worth at value creation. You also want a team and that is able to manage risk by looking 12-18 months ahead in order to protect the company’s blood line: its cash flow.

Skin in the Game

It’s one thing to have the track record and another thing to have skin in the game. My interests as a shareholder will be aligned with management only if they hold a significant piece of the company.

Company

Insider Holdings FD basis

Arcan Resources

12%

Hyperion Exploration

12%

Spartan Oil

26.9%

Pinecrest Energy

12%

Wildstream Exploration

22.8%

Anything above 10% is good but it’s even better when it’s above 20%. Given the upside potential for those companies at 12% FD, I believe the incentive is there to outperform. For example, Hyperion’s insider holding is only at 12% but the CEO invested a significant sum of his own money in the company at much higher prices so I am pretty sure our interests are aligned.

Conclusion

The variables discussed above are mere guidelines and by no means reflect all the variables that make of a company a compelling investment. Furthermore, a lot of risk has not been accounted for such as the weather or even political risk. Financial risk would be the biggest risk of all since the business is built around commodity prices. If fear grips markets again these companies will not be spared as investors flee stocks. Nonetheless, these guys know how to execute, they know how to set expectations and given the right commodity price environment they will repeat their successes. Finally, if oil prices were to plunge, it will only be a temporary event as long as we have not found a cheap and abundant source of energy that can fully replace it and until now we are far from it.

23 comments to Investing in Oil: 5 Junior Oil Stocks for 2012

I agree totally with all these picks, and the thought pattern behind them. I am biased as I hold 4 of the 5. Haha. I would add a category for debt, which all these companies would pass with flying colours. I especially like the category of management ownership. That is the biggest lesson I will be taking from the SKW fiasco. I also like that if you purchased them as a group you would have exposure to almost every emerging light oil play in western Canada. One question I have is do you think that the intermediate Nat. Gas companies will continue to outperform in 2012?

Oil price has come down since its highs. Do you think it’s a good time to enter a position in the overall sector? With the state of the economy, i’m somewhat surprised that the oil price isn’t higher at the moment.

Charles, we’re not out of the woods yet in my opinion but having said that I believe that oil prices will not collapse as supplies are tight. This means those who can execute will be rewarded by the market bar any global meltdown.

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I was wondering if you have talked to the Hyperion management lately? I noticed that the Paradise property was for sale through Sayer and I was wondering if you knew what they planned to do with the money or why they decided to bail on this asset?

NLR, Thanks for bringing it to my attention as I failed to notice this sale. I think this is a positive move since they will be able to focus on their Cardium core properties. Will catch up with management this week and update you.

Thanks for doing this little exercise. I found it to be enlightening. The main points that I am taking away from this analysis is that at this point junior companies need to be weighted towards oil or NGL’s which makes sense with the price of NG in the toilet. I agree that until we have some export facilities built it will probably remain low due to the excessive amount of gas found lately. Maybe found is not the right word, but been able to finally get access to.

Companies that are already proven producers with the ability to increase the production is much better the hoping on a prayer that they are able to find oil.

Management with a proven track record is very important and with them owning large portions of the company it shows to me that their interests are aligned with my own. A couple of other things that I like is little to no debt, incase of another retraction or collapse those companies that are not burdened with excessive debt will be more likely to survive and could even pick up other companies for pennies on the dollar.

I also like a company that pays a dividend while I wait for it to appreciate in value. It is nice to get a little money in your account while waiting. Besides that it beats the interest that I get in my savings account at the bank.

Sorry for the delay in getting back to you on this. I really appreciate the regular articles and the thoughtful process by which you analyze these companies.

I did a quick search on your site here and did not find anything (I could have easily missed it as well) on valuing an oil and gas company. I was wondering how you went about doing that.

I figure it would be taking the number of recoverable BOE’s multiplying it buy the current cost of oil and then taking that number and dividing it by the number of shares present in the company. Viola and you have a price per share that gives you an estimate of what the company should trade for. I also assume you would add in the any cash and subtract any liabilities.

While I don’t have a dedicated post on the subject, I sometimes I do some quick “back of the envelope” type of math in my posts. The easiest one is to go with $/flowing barrel which is basically the EV/current production.

Trying to do some dd on some Canadian oil juniors, but it appears many of them have popped already, so value also comes into play. The names I am doing dd on are Strad, Petrolia, Athabasca, Aroway, Petro One, IROC and Spartan, Hyperion, Arcan and Pinecrest ( which you mention above )Anyways I’m very familiar with Base/precious metals but this will be an entirely new learning curve. Thanks for the info.